The Fallacy of Channels: Startups Beware

This is part of my ongoing series on startup advice but also filed under my sales & marketing posts.

No advice I give will ever apply to 100% of companies, 100% of startups or even 100% of tech startups.  I just want to state that up front because while I believe that this post will apply to most startup technology companies out there, I’m sure there will be exceptions.  By all means light up my comments sections with any cases you believe where this advice doesn’t apply.

Let me start by saying that most channel relationships don’t work.  Period.  (Full Stop for you Brits.)  I’ve seen way too many startups spend all their energy getting channel deals done only to find out that they don’t produce ANY revenue.  Yet startups continue to pour tons of energy into a relationship that with the current structure will never work.  This post is dedicated to explaining why channel relationships suffer and how you can improve them.

A Channel Love Story

You’ve got the perfect product.  You’ve invested $1 million in building the perfect application the meet a large market need.  The only problem is that you can’t afford all of these expensive direct sales reps to go and sell it.  Nevermind.  There are these great big companies that have large sales departments looking to supplement their existing products so when they’re with clients they can increase their average order size.  Sort of amortizing the costs of their sales reps over more products.

Channel partners come in multiple flavors.  The favorite of many Silicon Valley startups is the Big Tech Co distrubution deal where you get to how off how effective your biz dev capabilities are.  Ink some deals with Salesforce.com, Intuit, Google, eBay, Verizon, etc. and you’re ready for your big round of VC investment to come in.  Or if you’re not planning to raise money you’re ready for the profits to roll in.

Or there’s the more old school deals with VARs (value added resellers) or consulting companies.  Here they’re already carrying a bag with products from many vendors so while there at the customer they just have to mention your product and budda bing.  It’s a perfect love story.  I got the brains, you got the looks, let’s make lots of money.

Except that most of the these deals end up going in the PR waste bucket.  Great inches eked out on tech blogs or industry rags.  End of story.

What Went Wrong?

Here’s the problem.  If you haven’t already sold enough of your product directly to have enough volume to satisfy your channel partner he/she simply won’t end up pushing it – no matter how excited their MBA adorned biz dev guy was when he inked your deal.

Imagine this.  You decide to go out and hire a sales rep.  He’s senior and used to earning $125k basic and $125k bonus.  Because you’re a startup he cuts you a deal (these sales guys are so good at this to work for only $120k basic in exchange for some equity [no, I’m not sales person bashing – I think sales reps are the lifeblood of any company – I’m just offering my realistic sense of a sales person’s salary negotiation strategy!].

So he decides to work for you without a guaranteed draw (which means his pipeline where he’s coming from wasn’t strong) and he hits the road selling your product.  And because it’s a nascent market, an evangelical sale and you have very little sales today the lead times to sell are longer than he’s used to.  The price points are not as high as your beautiful Excel spreadsheet had forecasted when you raised your seed capital.  So 3-6 month’s in your sales rep is complaining she’s not going to hit her numbers and earn her expected commission.  But at least you gave her a base so she’ll gladly bank that as she looks for her next job.

OK, I’m being harsh for emphasis but the reality isn’t far off of this.  People need to feed their families.  Channel partners are no different.  You think that Salesforce.com rep with a $1.2 million sales quota and the exact knowledge of how to sell salesforce automation tools is going to sell your dinky product that is unproven?  Heck, they can barely figure out how to sell all of the other Salesforce.com internal products let alone your product where they have to explain to their client that it isn’t part of his/her company.

People sell what they know how to sell to hit their quotas.  If your stuff flies off of the shelf then they’ll sell it all day long.  If it doesn’t they’ll soon forget what your product even does.  The sales market is as pure capitalism as it gets.  And your product isn’t going to fly off of the shelf.  Just do the math.  If they have $1.2 million quota to sell and your product sells for $20,000 / year (or even $100k / year. even $200k) – how much of it would they need to move in order to get their commission checks?  Don’t forget that when they sell their own products they get 100% margin.  On yours it’s at best 50/50.

So Should I Avoid Channels at all Costs When I’m a Startup?

No.  Not necessarily.  But here are my suggestions:

1. Limit your number of sales channel partners.  They will not sell on their own – they require even more training and nurturing than your in-house sales reps would

2. You still need to sell yourself, your channel partners fulfill the order.  What?  That’s crazy?  Then what’s the point of having them?  Well, I will tell you first off that in any sales channel relationship you need to sell the product before your partner does.  If you have a hard time selling they will have a harder time.  Channel partners will put the effort into training their people, developing sales collateral, bonusing their reps and moving other products off of their price list only when they know it’s dead easy to sell your product.

But channel partners give you huge credibility.  Imagine your visiting IBM and telling them to buy your product.  It sure would be easier if you announce Intuit as your channel partner and Intuit can actually sign the master services agreement and act as the single throat to choke when the order is signed.  Also, many businesses scale more cost effectively through channel partners.  So putting them in place now isn’t going to necessarily help you sell more products in the first year or two but once you’ve cracked the market then your partner will be ready / able to ramp up sales.

Also, channel partners are often your best potential acquirers and let’s be honest – most companies end up selling rather than IPO’ing these days.

So remember that you need to sell your product.  You need to market your product.  You need to stimulate demand.  Then hand the order over to your channel partner to “close” the deal.  P.S. Never let them actually close.  Don’t let anyone between you and a signed order.

3. Your partner needs to “earn” – Resist your temptation to be stingy.  ”But I did all the work!  Why should I share huge margin with my partners?  I’ll share it when they get off their arse and start selling!”  That’s missing the point.  You’re investing in your channel partners’ success in the early years so that they’re motivated in your scaling years.  That’s going to cost you margin.  It’s the definition of “investment.”

Margin deals can be all over the map.  My starting point mentally is about 30% for the channel partner.  You can get away with 25% if they’re not doing much.  You should be willing to go up to 50% if they play a significant role in the sales & marketing.  Also, another effective strategy is for you to take most (75-80%) of the sales margin but give them all of the service revenue (but then they actually have to do much of the implementation or servicing).  If anybody thinks these percentages are off please weigh in in the comments section.

4. You need channel resources – Most tech companies realize that they need Biz Dev resources to get lots of deals.  And frankly there’s lots of people running around wanting to be a Biz Dev person.  It’s a sexy title when you can’t design products, program  computers or sell! [yes, I’m joking. I love Biz Dev people – no hate comments, please ]

But where many startups under invest is in “channel managers.”  These are people whose job it is to manage the channel partners you do sign.  They need lots of love and attention.  They need to constantly be reminded of your company (they are by nature promiscuous).  You need to stay top of mind.  You need to go beyond their biz dev person and get to know actual sales reps, sales engineers and professional services staff.  They’re the ones who can help you identify customers that have a need for your product.  You then tip off your sales rep to focus on the deal and the channel partner gets their commission.  Everyone is happy.

Channel managers create channel partner specific marketing materials.  They help prospect deals together.  They understand the channel partner’s own product weakness and how your product helps them sell more of their core product (a sure recipe for you to get more sales).  They take the sales reps and extended staff out for drinks to remind them of what you do so you’re always top of mind.  They work on joint spiff programs with the channel partner. They are your lifeblood.  Know them. Hire them.  Without them you have great press.  Nothing more.

In summary I say that channels can be the lifeblood of startups.  In a world where we all raise less money we need to find more capital efficient ways of going to market.  But 80% of startups fail the channel test.  They understand how to ink the deal but not what makes their channel partner tick.  They end up being penny wise, pound foolish.  They blame their partners for not selling better rather than recognize the channel parter for what it is.

And I promise you.  If you start to make your channel partner successful – it will pay huge dividends when your business is ready to seriously hit that “j curve” you promised your investors.

(Cross-posted @ Both Sides of the Table )